Since the introduction of auto-enrolment there has been a significant spike in the number of people breaching lifetime allowance ‘protections’ according to new HMRC figures.
The figures were released following a freedom of information request by AJ Bell. The figures show that 12,000 investors have notified HMRC that they have lost one of the various forms of lifetime allowance protection, introduced since 2006 (when the lifetime allowance was first introduced).
Breaching these protections can lead to a significant tax bill, potentially running into hundreds of thousands of pounds.
There are concerns that auto-enrolment has led to an increase in these breaches, with people inadvertently contributing to a pension scheme and so invalidating these protections.
AJ Bell says this figures don’t show the reasons for all these protection breaches. However, it does show that 7,000 of these breaches occurred since the introduction of AE, with a spike seen since 2017, coinciding with the roll-out of the reforms to smaller businesses.
AJ Bell senior analyst Tom Selby says: “It is likely a significant proportion of these people accidentally broke the terms of their protection by failing to opt-out of their workplace scheme, either initially or at their re-enrolment date three years later. For these people the massive resulting tax bill will be a bitter pill to swallow.
There are four types of protection which can be lost when a member contributes to a pension scheme: enhanced protection, fixed protection (2012), fixed protection (2014) and fixed protection (2016).
Most of these protections, which effectively allow individuals to lock in a higher pension allowance, come with terms and conditions. In most cases these require individuals to make no further pension contributions.
However a recent court ruling offers some hope for individuals who inadvertently breach the terms of these protections by contributing to a workplace pension scheme.
At a recent first-tier tribunal ruling, the judge decided a man who had accidentally voided his lifetime allowance fixed protection by failing to cancel a contribution standing order should have the protection reinstated.
However HMRC is understood to be appealing this ruling.
Selby adds: ““The lifetime allowance is a pernicious tax which effectively punishes defined contribution savers who enjoy strong investment performance.
“Furthermore, successive cuts to the allowance in recent years have created a complex web of protections designed to protect people close to the lifetime limit from being unfairly penalised.”
He adds: “A number of these protections come with terms and conditions – namely that you are no longer allowed to contribute to a pension scheme. If you do, the protection is lost and you could face a huge tax bill on the excess.”
AJ Bell points out that someone with a £1.25m fund who took out fixed protection 2016 and subsequently lost it in the 2018/19 tax year would face a tax bill of £121,000 on the excess.
AJ Bell is calling for further simplification of the pension tax rules.
Selby says: “Whether it is doctors being hit with tax bills for breaching the annual allowance taper or savers losing fixed protection after contributing to a pension, it’s clear the inherent complexity of the pensions system is causing problems for higher earners.
“The Government should review the pension tax regime and consider simpler alternatives which don’t unnecessarily hamper those doing the right thing and saving for retirement.
“One option would be to create separate tax regimes, with defined benefit schemes controlled by a lifetime allowance and defined contribution by a single annual allowance. This would allow the Treasury to keep a lid on costs and in the process remove huge complexity from the system.”